Dominic J. Frederico

Dominic J. Frederico
President and CEO

Assured Guaranty Ltd

Dominic has been President and Chief Executive Officer of Assured Guaranty Ltd since 2003. Before taking up his current appointment, Dominic was the Chairman of ACE Financial Services. Prior to joining ACE, Dominic spent 13 years working for various subsidiaries of the American International Group.

He holds an M.B.A. in Finance, a B.S. and a Certified Public Accountants designation. In addition to his professional responsibilities, he is a Member of the American Institute of Certified Public Accountants and the Pennsylvania Institute of Certified Public Accountants.

 

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A view from the top

In this short video, Dominic J. Frederico shares his view on today's key business issues: risk, volatility, innovation, talent, and growth

Quotes

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

Government officials first and foremost have to remember that they govern for all people. And if people need a solution, then it’s up to the government heads to craft that solution, which sometimes requires compromises.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

Everything is a process, a process that has, you know, raw material and input, a process in and output, and how do you match the two? So in the state government, it’s exactly that. What am I paying on this end? What can I possibly collect on that end and how do I make the two meet? This is not about me making money. It’s not about me losing money. It’s about me providing the service and making sure that there’s a reasonable basis for how I allocate the cost of that service to, you know, the recipients.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

We constantly look at what we’re learning from today’s experience and adjust our views of the future in terms of what business we can write, what business we can engineer the risk out of where there’s a reasonable prospect we could take the risk at a reasonable premium and make a profit.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

In Portugal, Spain, Greece, and Italy, for example, the governments have their hands in everything. Although we don’t have any significant sovereign risk, the financial condition of those countries has a tremendous impact on our exposure. For example, we were looking to do a hospital transaction in Portugal, but based on the country’s economic problems, we pulled that deal off the table. So there are impacts in today’s economy that have forced us to make changes, and I don’t see them quickly reversing themselves in the new year.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

For us, emerging markets do not present the same level of opportunity as they do for other companies. We need a developed system of law and rights under contracts that you don’t see in the early stages of an emerging market. We need an active bond market, because there has to be liquidity and the ability to trade in and out, and that doesn’t exist in emerging markets.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

Every year, I present a succession plan to our board, and it’s become more difficult. In the old days, succession would be a guy who you thought knew the product or the business really well and then needed to have managerial or leadership skills. Our business today probably puts as much premium on negotiation and communication skills.

Dominic J. Frederico

Dominic J. Frederico

President and CEO, Assured Guaranty Ltd

The challenge is not only to identify your successor, because a lot of things could happen on the way to that point of succession, but to look three levels down, to whom else I think has the right amount of talent.

 

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What is your current outlook for the global economy, as well as the different factors you consider when you look at growth both in the US and overseas?

Our business is basically predicated on growth in both Europe and the United States. As we look at Europe, the economic outlook is for flat to no growth across the continent, which is where the majority of our non-U.S. business is located. In the US, where most of our business is municipal based-in individual states and local governments that issue bonds-this was a very depressed year for issuance. With interest rates staying low, we expect issuance to pick up next year, and there are some forecasters calling for a fairly strong bond issuance year. I don’t see that, however, because you still have a balance of payments, cash in versus cash out. Municipalities remain stressed from a budgetary point of view, therefore that’s going to limit the amount of new construction and other new projects which they could consider. So we’re looking for reasonable growth in the U.S. for our business.

In Europe we’re looking at very little growth.  We haven’t had much success in Europe in the last two years because of the uncertainty in the bond insurance market. I think there will be growth for us versus what the general European economy will do, just because of the fact that there was no insurance penetration in the last two years, and we expect that to pick up going into 2012 now that S&P has assigned us stable ratings in the AA category.

With the current mix of volatile circumstances-economic uncertainty, natural disasters, or political upheavals over the past year-what has been the volatility level for Assured Guaranty?

Volatility for us is predicated, first, internally on the company, and then on our ratings in the business of insuring credit risk. The issuer, or the obligor, uses our insurance to improve the market’s perception of the creditworthiness of that instrument.   So the first threat to the product, or to our opportunities, is our ratings. The rating agencies have been under attack because they made some rather serious mistakes back in 2007 and 2008 relative to how they rated certain instruments that were tied to US mortgages, and there’s been an overreaction on their part. The rating agencies have taken a very different look at how they rate our company and our industry, which has been detrimental to us. Over the last two years we’ve been on either a rating Outlook Negative or a rating Watch Negative at least one rating agency, and that uncertainty in the market had the most impact on Assured Guaranty and our position relative to being able to write business.

The only benefit, if you can call it that, is that we were the only company that maintained any viable ratings in our marketplace, so we were the best option at the time. We’ve continued to show profitability, further improvement in capital position, and further run-off or improvement of our portfolio of insured risks. By and large, we have weathered the global financial crisis very well, maintaining reasonably high ratings, in the AA category, which today in the financial markets are some of the highest ratings from the agencies. We’re challenged, but in a position where we believe the worst is behind us and we are looking for a pickup in business because of the stability of our rating from S&P.  It is really stable financial strength ratings that dictate the acceptance of our product.

Are those ratings then the number one risk to Assured Guaranty’s growth that you’re most concerned about, or are there other factors?

For most companies, risk, first and foremost, relates to their specific business, and in our case it’s our ratings. However, we are also susceptible to risk from other areas, particularly either legislative or regulatory. On the regulatory side, there’s been movement to restrict the use of derivatives. We used to write about a third of our book of business by guaranteeing derivatives contracts. If, under the new Dodd-Frank Act, a company has to post collateral to execute a derivative transaction, that will drive everybody out of the derivative markets, because the industry theoretically could be risking hundreds of billions of dollars.

Second, in the way we’re structured-with a Bermuda holding company, US subsidiaries, and UK subsidiaries-to the extent that the US changes the tax view of what a Bermuda domicile means, and how they’re going to restrict a premium ceded from a US company to an offshore company, that could have an impact.

Number three, again under Dodd-Frank, there is now a federal insurance office. Whether it decides to regulate our industry could dramatically change how we do business, what business we’re allowed to do, and how much business we’re allowed to write. Stacking those factors on top of each other, ratings are our number one risk, but there are other risks in the marketplace that we are as concerned about going forward.

How much do the fiscal policies of domestic and foreign governments, especially at the municipal level, worry you?

We’re very concerned, and I’ll take it into a more specific context. We write insurance for state- or municipality-issued bonds. We do a full underwriting of the issuer-its availability of funds, sources of funds, diversity of funds, and ability to increase in down cycles the flow of funds, their access to other unallocated or previously unencumbered funds to support the borrowing or the debt service.

Today, many municipalities are looking for the ability to abdicate some of their responsibility. For example, say a municipality issues a bond with our insurance and agrees to raise taxes if necessary to support the debt service; then, all of a sudden, because of the downturn in the economy and how its revenue base was constructed, that municipality is seeing a revenue shortfall. It’s not politically popular to raise taxes today, and although our contract specifically calls for that, the municipality decides it’s not going to do that, but instead wants to file for bankruptcy and have debt service fall on their bond insurance. Part of the deal, however, is that they are supposed to exhaust all means possible to provide adequate cash flow to service that debt. When some local government wants to access the insurance and abdicate its responsibilities to either have balanced budgets or find additional sources of revenue, I have a big issue with that type of behaviour.

What should governments do to avoid that type of behaviour?

Now we’re getting into politics, but government officials first and foremost have to remember that they govern for all people. And if people need a solution, then it’s up to the government heads to craft that solution, which sometimes requires compromises. So today if you look across all levels of government, first there has to be a re-recognition of what is a reasonable tax base against expenditures. Then, when you look at the revenue, did we attach to the revenue in the proper way?

It’s the government’s recognition of its responsibility. I have an engineering background, which involves knowing about my inputs and my outputs. It’s a very simple business. Everything is a process that has an input and an output, and knowing how to match the two. In a state government, it’s exactly that. What am I paying on this end, what can I collect on that end, and how do I make the two meet? This is not about making money or losing money. It’s about providing service and making sure there’s a reasonable basis for allocating the cost of that service to the recipients.

And does that same basic situation exist throughout Assured Guaranty’s various global markets?

I think it does. What makes it different around the globe is the economic outlook, the size of potential sources versus the obligations. We think we have a fairly high level of benefits, of social programs built into the structure in the U.S.  If you go around certain countries in Europe-and I lived in Europe for a number of years-you’ll find that the social structures there are even steeper. They have tax rates that accordingly reflect that, which is why certain countries are very attractive to live in and others are not. In the United States, municipalities could create for themselves a competitive advantage or disadvantage, depending on how governments spread their obligations across all constituents.

Have there been some actions governments or multilateral organisations have taken to create a positive impact on economic conditions?

In the US, keeping interest rates very low is both a positive and a negative for the economy. If you don’t show real interest rates, there’s no reason for individuals to invest. If I’m going to earn 25 basis points on my savings, there’s not much incentive for me to save. Therefore, because many people’s ultimate goal is to build a retirement fund, if they have no real return in the market, that’s going to make it very difficult to achieve that goal.

Look at Japan, which went through 20 years of virtually zero interest rates. I don’t think that did them much good. I see that kind of behaviour here, and while I don’t think that’s the way it has to be, it has helped in a way. To get over a credit crisis, making credit cheap is one way to do it, but then at the end of the day you need inflation. We seem to want to fight that, but inflation is like the tide that lifts all boats. It really would help with the evaluation side of the market, especially in real estate. If there’s one big thing that’s continually going to drag down the US economy and make a significant impairment or impediment to any real growth, it’s the US real estate market.

Too many people rely on the US real estate market as either their biggest savings account or their retirement. With no value being achieved in the market, that’s going to create more pressure in the whole process. I have not seen anything from the government, either a policy or a proposal, to address that. We spend a ton of money on infrastructure at the Federal level, but that has done very little relative to unemployment or the economy. Take those same dollars and forgive everybody 20 percent of their mortgage. For those who don’t take 20 percent, lower their interest rate. If the government lets banks borrow at 25 basis points, why not just give it to the consumer, where it’s going to have the most benefit?

Given all these circumstances and the various levels of volatility over the past year, did Assured Guaranty have to change its overall strategy?

Because we’re in a risk-taking industry, we have to change our risk-taking appetite relative to what we would identify as the elements or the environment in which we transact business. For us it’s been more of an increase in our credit underwriting requirements, a further pushing out of our underwriting standards. Our US municipal business today, is focused more on tax-backed, revenue-backed, general-obligation bonds as opposed to specific projects. In healthcare, for instance, we’ve stayed away from projects such as special-care facilities, because they’ve always been very thin on the revenue side. We’ve looked at the asset-backed world and said, Okay, we now know how much potential fraud is embedded in the home mortgage process, and as an underwriter you have to make sure you can cordon off risk or control it. So when fraud is rampant and you can’t control it, you have to remove yourself from the market.

We constantly look at what we’re learning from today’s experience and adjust our views of the future in terms of what business we can write, what business we can engineer the risk out of where there’s a reasonable prospect we could take the risk at a reasonable premium and make a profit.

Will you have to make further strategic changes to react to that continuation?

Looking at residential mortgage-backed securities, in order for us to ever get back into that business, there would have to be dramatic changes to the contractual structure around the risk to give us more and stronger rights upfront. As a financial guarantor, we have to pay a claim to the policyholder and then argue about it or litigate it later with the sponsor, depositor or originator. In the mortgage business we have paid probably $3.5 billion in claims. We might be able to recover a substantial amount of those claims, but, in the interim, we’re still out $3.5 billion. The regulatory bodies charged with resolving the R&W violations aren’t worrying about that, which is why our ratings get threatened and the perception of the quality of our product gets impaired.

Now, if the contract said I get paid first, that would be a different story, but that’s not the way it works. Those nuances in our US business force you to make further changes. That’s probably not the same way as we look at our risk in Europe. In Portugal, Spain, Greece, and Italy, for example, the governments have their hands in everything. Although we don’t have any significant sovereign risk, the financial condition of those countries has a tremendous impact on our exposure. For example, we were looking to do a hospital transaction in Portugal, but based on the country’s economic problems, we pulled that deal off the table. So there are impacts in today’s economy that have forced us to make changes, and I don’t see them quickly reversing themselves in the new year.

You just referred to developed markets overseas. What about emerging markets, which was a major focus of CEOs in last year’s survey. What’s your position and prospects for emerging markets?

For us, emerging markets do not present the same level of opportunity as they do for other companies. We need a developed system of law and rights under contracts that you don’t see in the early stages of an emerging market. We need an active bond market, because there has to be liquidity and the ability to trade in and out, and that doesn’t exist in emerging markets.

In that sense, how has building relationships and partnerships become more important to your success?

Our municipal business in the US is typically brought to us by big investment and issuing banks, and we continue to foster and maintain those strong relationships. Europe is a different market, and there we look at infrastructure. A construction firm, for example, will put together a consortium to bid on building a railroad, a hospital, a tunnel, whatever the case may be. We have relationships with those large construction firms, because they bring in the insurer and the banker. So we probably count on a hundred contacts to drive the majority of our business.

Have environmental or social issues become an element of your operations?

The essential issues for us are more relative to the breaking point for taxes and tax levies and sources of revenues. Remember, we’re all about repayment of debt or repayment of obligations. So if municipalities continue to put large benefits packages on the table, how they get funded is a critical issue for us. For example, Detroit is experiencing a huge downturn in its economy and high unemployment, resulting in a tremendous loss of revenue into the municipality. The state of Michigan had to step in to assist Detroit in managing its debt and financial obligations. It’s going to take a long time to resurrect Detroit, though the continuing success of Chrysler and the amount of investment they’re making there may help. We’ll see how that pans out, but our issue on the social side is more about benefits against revenue and who’s accounting for the revenue.

In the wake of all the economic turmoil over the past couple of years, and its impact on your industry, Assured Guaranty’s major competitors have gone out of business, leaving you as “the last man standing.” Is competition not a factor for you? Do you wish you had direct competitors?

Part of me says, yes, any industry has to be greater than one. But then I’m sure Coca-Cola wishes there wasn’t Pepsi, and Ford wishes there had never been a General Motors. So it’s hard for me to take that high intellectual level and say competition is good in every case.

One positive aspect of the lack of direct competition is that when we submit a quote for a piece of business, no one’s going to offer a similar product for a lower price or weaker terms and conditions. If we’re doing business with a hospital, I want a mortgage on that property so I own the building if they default on my bond. Back in 2006, when there were seven total players in the industry, there were a lot of people waiving mortgage requirements. That’s not the smart thing to do, because, remember, the hospital is not going to be more than an operational risk. Can you continue to generate revenues in excess of your expenses, including debt service? That’s a factor of how good of a job you do in the competitive environment. It’s a different risk entirely. That’s why you have to protect yourself, and in those days, people would waive those terms and conditions. It’s nice not to have to worry about that these days.

Competition will come back into the market, but we’re always competing, regardless of whether there’s another bond insurer out there. If you look at this year, roughly 95 percent of all US municipal issuance was issued without insurance. That’s our competition, the uninsured market. On the structured side, we did three or four direct, new-money structured finance deals. How many billions of dollars of auto securitisations and credit card securitisations went out that never used insurance as a product? Our competitive environment is not limited to whether there’s another financial guarantor. Our real competitive environment is the uninsured execution.

Let’s talk about your unique environment for talent. Even though Assured Guaranty has only about 300 specialised employees, has talent become a strategic issue for you?

It hasn’t, but that is because of the unique nature of our business. A few years ago there were seven AAA-rated companies doing direct financial guarantee insurance. Today there is one-Assured Guaranty. As a result, there is a tremendous amount of talent on the streets. Also, because most of our business is done with banks-including Goldman Sachs, Bank of America, Merrill Lynch, JP Morgan Chase, and Citibank-the person on the other side of the transaction is experienced or knowledgeable enough to work for us. When we lose people, we typically lose them to the banks, and when we hire people, we typically hire them from the banks. And the banks have the same problem of reducing staff over the last three years. So in our business there’s a surplus of talent available, not a scarcity.

Does that present a challenge when you need to bring in new talent, that there is too large a pool from which to find the best and the brightest?

I try to stay away from using employment agencies and headhunters. They’ll tell you who their best candidate is. I trust our senior management team. Most of them have grown up in the industry, which is very close-knit. People change hats, but they never change uniforms. Therefore, if we’re looking for somebody in surveillance, I’ll go to our head of surveillance and say, “Who do you know in the market? Who have you come up against?” Because I’d rather bring in somebody we know than somebody we don’t know.

It’s also not just talent, but also personality, especially in a small company like ours. You could have the brightest guy, but if he can’t work with people, or if he has a different view of where his career is going to go versus the rest of the people in his department, that’s going to create a problem.

In this volatile environment, have your requirements for senior leadership changed?

No, we were fortunate in that, of the seven direct AAA-rated companies in our industry, the two strongest survived, and we wound up buying the other survivor. We’ve had more of a challenge of integrating talent than anything else.

Has that impacted your succession strategy?

Succession has evolved for us. Every year, I present a succession plan to our board, and it’s become more difficult. In the old days, succession would be a guy who you thought knew the product or the business really well and then needed to have managerial or leadership skills. Our business today probably puts as much premium on negotiation and communication skills. When you look at the threats from the rating agencies, you have to talk to the agencies and, in effect, negotiate what position they want to take vis-à-vis your risk versus what you think is the proper position.

Are you confident that the pipeline is there to bring along that type of talent?

I’m fortunate in that I believe we have a successor in the company today who could become the next CEO. I always look at who I think can be developed and ultimately get to that level. The challenge is not only to identify your successor, because a lot of things could happen on the way to that point of succession, but to look three levels down, to whom else I think has the right amount of talent.

The problem today is, too, that the challenges of the CEO have dramatically changed. For instance, I can’t imagine a CEO who doesn’t understand the financial side, because now you’re putting your signature on your company’s 10-K form, on your 10-Q form, and on your representation letters, and you’d better understand what you just signed. Without a good grasp of the financial side, I don’t know how you do that. Is the head salesman who comes up and runs the company really capable of understanding all the financial implications? And when you look at things like Dodd-Frank and Sarbanes-Oxley, especially in the financial markets, it’s become a legal, an accounting, and an actuarial beast.

Yes, you ought to know your product, who your customers are, and how you’re going to service them, and maintain relationships, but if you don’t understand those other areas, I’m not so sure how successful you can be. Therefore, as the demands of the job have changed, it has become more challenging to identify a candidate who can wear all those hats.

Speaking of your evolving responsibilities as Assured Guaranty’s CEO, how has the allocation of your time and demands changed over the past year?

It’s been more of an external challenge with regard to who I need to interface with more. In today’s volatile economic world, you’d better know who your largest shareholders are, and they’d better know who you are. You need to give them access so that if, say, your stock drops three points in a day, you know you’re going to get some phone calls. You’ve got to be able to respond. Obviously, too, one of my biggest communications is to the board, which is my ultimate boss.

Similarly, we have some major issues to negotiate-settlements, agreements, et cetera-and I need to be a part of that process. I’ve always been very acquisitive. I believe that one way to move the needle is through acquisitions and consolidations. In our business, with the industry decimated, there are a lot of stranded companies that still have valuable assets. My challenge is to acquire those valuable assets and build the value of our company.

For you, then, is this the new normal, or will there be a return to a former normal?

I would hope that the business gets back to what it was in years past, which means we provide a service: access to the market for a given person who needs financing at a cheaper cost. To the investor, we provide negotiation to better protect that asset. We continue the surveillance of it, we provide loss mitigation where necessary, and in the event of a default, we pay principal and interest. There is value to that proposition on both sides, because it’s a win for both the issuer and for the investor. It would be nice to get back there, to eliminate the fraud side, and to get this nice high-margin business where everyone feels good about it.